The Welfare Effects of Tax Competition Reconsidered: Politicians and Political Institutions

The views on the welfare effects of tax competition differ widely. Some see the fiscal externalities as the cause for underprovision of public goods, while others see tax competition as means to reduce government inefficiencies. We build a model that allows for both views by taking politics seriously. Using a comparative politics approach we show that tax competition among presidential-congressional democ- racies is typcially welfare improving, while harmful among parliamen- tary democracies if under the latter the marginal benefit of the public good is sufficiently high. The results hold when politicians seek re- election because of exogenous benefits of holding office. By contrast, when politicians hold o¢ ce only to extract rents, tax competition is harmful if politicians are sufficiently patient.